What is a Pyramid Scheme? Avoid Losing Your Money This Way

If it’s too good to be true… it probably is.

That’s really all I should need to say about pyramid schemes.

These illegal money making schemes exist as a way to milk naive investors out of their money with the promise of extreme wealth. The promises made are actually unattainable and therefore the scheme should be illegal.

However, due to issues surrounding the identification of what they actually offer, these schemes are sometimes allowed to operate, masquerading as legitimate enterprises.

If you are level-headed, dispassionate in your analysis, and have a keen nose for bullshit, you will be fine.

As ever, be aware.

In this article, we’ll look at:

The structure of a pyramid scheme

How to identify one

The connection to multilevel marketing

Some common pyramid schemes

So…

What is a Pyramid Scheme?

A pyramid scheme works by recruiting more and more people into the bottom level of the marketing structure.

If I wanted to start such a scheme, it would go something like this:

1. I would be level 1 at the top of the pyramid. I would get two people to join my company to promote it. They would both pay a joining fee to me and they would sit at level 2 of the pyramid.

2. Those two “sellers” would then go out and persuade another two people each to join the scheme. Those four new “sellers” would pay a joining fee. A percentage of the fee would go to me and a percentage would go to the level 2 guys. The four new “sellers” would sit at level 3.

3. Those four new “sellers” would go out and recruit another two individuals each. That would make eight new “sellers”, who would sit at level 4 of the pyramid. Those eight individuals would pay a joining fee. The people in the above levels would divide this money between them in varying amounts.

And so it would continue, with the bottom level doubling in size with each new recruitment.

Happy days for the guys at the top.

The Numbers Don’t Work Out

Anyone can see that the exponential nature of the maths means that sooner or later, the scheme would need to recruit insane numbers of new participants to keep it going.

And that is just with each new member only finding another two punters. If they were to try to find more then… well obviously that would bring the whole thing down even faster.

How to Identify a Pyramid Scheme

One of the major signs of a pyramid scheme is that getting new people to join is where most of the potential profit is.

If you are the skeptical, reasoning person that I think you are, then you will be asking yourself, “Why would anyone pay money to enter something like that?”

Good question. It seems weird that anyone would freely give up their cash just for the prospect of having to find other people to give up their cash, too. But…

It’s Human Nature

One of the issues is the simplicity with which the sellers often present such schemes as a way to make money. It’s no secret that humans are often greedy and flashing the possibility of easy riches before their eyes is often too much for them to resist.

If they are told that they ONLY need to recruit two people, it seems easy.

And when they see the simple diagram of the pyramid going from 2 to 4 to 8 to 16, as the levels expand beneath them, then their eyes glaze over with dollar signs.

Sometimes, that’s all it takes.

Okay, that might be being a little harsh on the intelligence of a lot of people. Although schemes as simple as this have existed in the past, today the majority of common pyramid schemes require a little more incentive to get people to join.

So, sellers encourage new entrants to join by offering them goods or services to consume.

The Difficulty of Assessing Value

This is where the nebulous nature of such marketing comes in, as it can be very difficult to accurately assess the value of what you receive. It could be some physical goods, but is more likely to be some training or similar.

Whatever it is, the new entrants are still encouraged to go out and get others involved, as this is where they realise they will make money.

The scheme is still really about making money from new meat, rather than the utility of its “products”. This grey area is what makes it difficult to accurately label some enterprises as dishonest and illegal.

With the expansion of the Internet, it has become easy for people to reach a wide audience who they can offer easily-accessible digital products. These buyers are then offered high commissions for selling on the same products.

This means a lot of Internet marketing systems draw very strong parallels with the pyramid business structure.

Always Stop and Think Twice

If you are looking to enter something like this, think about what they are promising you, and what they are asking you to do.

If you are being promised easy riches, then think twice.

When someone asks you to purchase something, and then become a sales person for that product, think twice.

Pyramid Schemes and Multi-Level Marketing

It’s no surprise that companies that use a multi level marketing business model often get accused of being pyramid schemes.

Even big companies like Herbalife and Amway do not escape such accusations, despite having massive market capitalizations and being household names.

ALL MLM enterprises sell themselves primarily as ways to start your own business. The quality of the products is a secondary motivation for people entering these organisations.

The problem is, how likely is it for any one individual to make a big business out of it? How many people start… and how many of them end up as millionaires?

You could be forgiven for getting involved as these big players have been around for a long time and have a lot of experience in selling dreams. Sadly, the online marketing arena is full of these kinds of operations.

Common Pyramid Schemes

Here is a link to a list of pyramid schemes. It’s shocking really that so many are allowed to operate, and I’m sure that is just a fraction of what’s really out there.

Note: the page says these are companies have had warnings against them, so they are obviously operating in that grey zone.

When you enter into the realm of nutrition and supplements, you enter a world of common pyramid scheme products. You will often find the biggest zealots here.

Someone trying to recruit you into the scheme will swear by the supplement’s efficacy, which may or may not work, who knows?

But they will always be trying to get you to invest in the sales side, because they are desperate to make back their joining fees… and they still have visions of that ever expanding down line, making it rain dollars into their bank account.

Pyramid Scheme vs Ponzi Scheme

A pyramid scheme is not a ponzi scheme, although the two do share some similarities.

A ponzi scheme is an out and out fraud that attracts new investors with the promise of spectacular returns. The new capital is used to pay out said spectacular “returns” to the existing investors. The capital never actually gets invested anywhere.

What is your opinion on pyramid schemes? Have you had an involvement in one? Do you think we need more protection from them? Please leave your comments below.

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4 Comments

James, when I was a kid I was ALWAYS attracted to pyramid schemes! I had dreams of working in my pajamas from home and being the richest kid on the block. 🙂 Nice article dissecting pyramid schemes and differentiating between a Ponzi scheme.

Hello,
Good to be here. I think it’s my first time reading your blog and I won’t just step away without dropping a comment.
Pyramid and Ponzies abound today and some folks are out there just scouting the net for such opportunities. They seek to be the first to enter the network for that is where the money is made. This ends up generally leaving those at the bottom lamenting.

I’m very careful about what I promote these days not to drag my community into shame 😉